Overdrafts on prepaid cards: Good deal, or debt trap?

Some like to borrow against them; feds consider rules to ban the option

Overdraft programs on prepaid cards are sneaky, high-cost loans that should be outlawed, consumer advocates say. But several customers of one card company couldn't disagree more.

"I rely heavily on the services that my NetSpend card provides me," wrote Clifton Allen of Seattle in a comment filed with the Consumer Financial Protection Bureau. "Since Washington State has removed most of the payday loan operations, NetSpend's cash advances have been life savers."

Allen's comment is part of a battle in a longer-running dispute about fee-based overdraft programs. Lenders say they're a customer convenience, while consumer advocates call them an end-run around rules against costly payday loans. After a battle over banks' overdraft programs that resulted in regulations forcing clear opt-in procedures, focus is now shifting to prepaid cards, which are emerging as an alternative to bank accounts.

Feds eye new prepaid rules
The CFPB is working on rules for reloadable prepaid cards, which can receive deposits and be used like a debit card to make purchases and pay bills -- much like a bank account. But unlike banks, prepaid cards do not face rules about the disclosure of their fees and terms.

For now, overdraft programs are rare among prepaid cards, with major issuers such as Green Dot, Chase Liquid and American Express Bluebird not offering credit features. NetSpend is an exception. The company, which specializes in reloadable prepaid cards for "unbanked" consumers, has more than 2.35 million cardholders. About one in five of its customers are eligible for the overdraft plan and 6 percent actively use it, the company says.

Allen was one of 22 NetSpend customers who wrote to the regulatory agency applauding NetSpend in July. Eleven of them specifically defended NetSpend's overdraft plan, which charges up to $45 in a month for up to $100 in short-term credit, depending on the number of overdrafts.

The comments, all filed about two weeks before the comment period ended, did not come out of the blue. NetSpend sent a message to customers about the coming regulation, along with a link to the regulator's website, and invited them to submit their views.

"We took a risk ... (but) we're very confident about what we provide," NetSpend spokeswoman Krista Shepard says. The company sent the message via its online system for customers, she says. "We know they like our product." No other prepaid companies' customers filed comments.

Consumer advocates suggest another reason behind the favorable reviews. Overdraft users can be trapped in a cycle of debt and fearful of being cut off, they say. NetSpend's fees, which can amount to an interest rate of 2,000 percent or more, absorb much of the money recipients get from the loan, digging users deeper into a financial hole.

"People think they're getting a favor, but it's an exorbitant loan," says Lauren Saunders, managing attorney in Washington, D.C., for the National Consumer Law Center. "Once you've gotten into the cycle, you really do need it (the overdraft) next month, because you've gotten behind."

Some NetSpend customers did sound concerned about losing the feature in comments they filed with the consumer bureau. Joseph Mangiamelli of Nebraska said he uses the overdraft sometimes to buy food and medication toward the end of the month. That's when his Social Security Disability payment arrives via a credit on his NetSpend card. "I'm sure that my financial well-being would not be as well off if I had to stop using this card," he wrote.

People think they're getting a favor, but it's an exorbitant loan.

-- Lauren Saunders
National Consumer Law Center

Shepard says that NetSpend did not influence customers' comments. The company's message to customers repeated information from the consumer bureau's site, she says, and customers lodged their comments directly to regulators, not through NetSpend. She declined to provide a copy of the message.

The consumer protection bureau opened the public comment period in May as a step toward writing regulations for the booming prepaid card business. The cards are expected to hold $167 billion of consumers' money in 2014, up from just $12 billion in 2007, according to the consumer bureau. Frequently the cards are the way people such as Mangiamelli receive benefit checks.

Consumer advocates say that prepaid cards should live up to their name and be free of credit features. Prepaids are a way for consumers to get control of their spending, not another route to high-cost borrowing, the argument goes. Permitting overdrafts will allow card issuers to evade restrictions on payday loans and promote a "race to the bottom," according to comments submitted jointly by the National Consumer Law Center, the Center for Responsible Lending and the Consumer Federation of America. Consumers Union also recommended prohibiting overdrafts in a separate filing.

The consumer protection bureau will consider all the public comments when it reviews the record, spokeswoman Michelle Person says. She says the bureau won't comment about the NetSpend customers' comments, and referred questions about the validity of the customers' views to the company. The bureau is expected to issue proposed rules for prepaid cards late in 2013 or sometime in 2014.

We've designed this (overdraft) program in a responsible way ... For people who are struggling out there, this is important to them.

-- Krista Shepard
NetSpend

Shepard strongly disagreed with suggestions that customers spoke up for overdrafts because they have become dependent on costly credit. Rather, she says, the company's customers are aware that NetSpend's program is a bargain compared to banks' costly overdraft plans, where fees on a two-week $100 overdraft equate to an APR of as high as 3,250 percent.

"We've designed this program in a responsible way," she says. "For people who are struggling out there, this is important to them."

Overdraft program details
Customers must opt in to overdraft, and they must have at least $200 in recurring direct deposits to qualify. For overdrafts of less than $10 the company waives fees, and the amount is made up with the next deposit. There is also a 24-hour grace period, during which a customer can correct the overdraft and avoid a fee. In the first half of this year, 66 percent of overdrafts were not assessed a fee, Shepard says, showing that many people benefit from the feature without incurring costs.

On the other hand, people who repeatedly use the overdraft are given "cooling off periods" during which overdraft privileges are suspended, she says. The suspension is imposed after racking up 12 overdrafts within 12 months. If after two cooling-off periods the customer continues to repeatedly use overdrafts, their overdraft privileges are canceled."We tell people, 'If you need a credit card, this is not the program for you,'" Shepard says. "This should be more for emergency purposes." The company's policies provide a model for how prepaid overdrafts can work for consumers, she says.

Saunders of the consumer law center argued that the best model for prepaid cards is to steer clear of offering credit altogether. People who do need a short-term loan to tide them over for necessities should tap sources like friends or family, or some credit unions, instead of incurring fees for a loan that may last only a few days. "You should go to sources you can't go to very often," she says, "that won't let you come back, and back, and back."

Published: December 24, 2012

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